Home' A Plus Magazine : July 2013 Contents HKFRS
48 July 2013
Gary Stevenson is director, technical and training, at
BDO Hong Kong.
Where an unvested award is cancelled it is
therefore necessary to determine whether
this is a consequence of forfeiture or not.
A director of company X voluntarily cancels
unvested share options.
This cancellation is accounted for as an
accelerated vesting and not as a forfeiture
even though it was at the choice of the
director as it does not result from failure to
meet a vesting condition.
7. Convertible notes:
Conversion rights, which result in the
exchange of a fixed amount of cash for a fixed
number of shares, are classified as equity. If
this test is not met they are accounted for as a
derivative financial liability. Convertible notes
may include anti-dilution clauses to protect
the note holder when one or more dilutive
events occur, for example, bonus issues,
share splits or rights issues.
Although such clauses result in a variable
number of shares being issued, they are
not considered to fail the fixed-for-fixed
test provided the effect is to maintain the
relative rights of the note holders and equity
shareholders before and after the dilutive
event. The terms of anti-dilution clauses
need to be considered carefully therefore to
determine the substance of any adjustments.
An entity issues a convertible note with a
conversion price of HK$1. The note contains
an anti-dilution clause which resets the
conversion price to the lower of HK$1 and the
price of any new shares which are issued at
full market value.
This adjustment fails the fixed-for-fixed
test as it compensates the note holders if new
shares are issued at a market price which is
lower than the conversion price. Other equity
shareholders do not enjoy a similar benefit.
8. Current liabilities:
classification of convertible
Where a convertible note is accounted for
as a compound financial instrument the
debt and equity components are presented
separately. The debt component is classified
as a current or non-current liability depending
on the terms of the note. Any terms that
could, at the option of the counterparty, result
in settlement of the note by the issue of equity
instruments do not affect this classification.
The possibility of conversion is ignored
therefore and only the repayment terms
of the debt component are considered.
Convertible notes may often contain
embedded put options. Irrespective of
whether these embedded derivatives are
accounted for separately or as part of the
debt component they are always relevant to
the current or non-current classification of
Entity Y issued a five-year convertible note
on 1 March 2011, which is accounted for as
a compound financial instrument. The note
is convertible into ordinary shares at the
option of the holder at any time after issue.
The terms also include an embedded put
option, exercisable by the holder from the
second anniversary of the date of issue of
the note. The option has been accounted for
separately as a derivative financial liability.
Entity Y classifies the debt component
of the note as non-current in its financial
statements for the year ended 31 December
2011. The fact that the note can be settled
by issuing shares within 12 months does
not affect this classification. Entity Y will
however classify the debt component as a
current liability in the following financial
year as it cannot avoid the obligation to
settle the note in cash within 12 months if the
holder exercises the put option.
9. Financial instruments:
dealing in commodities
Contracts to buy and sell non-financial items
such as commodities are accounted for as
derivatives where the contracts can be settled
net in cash unless they are entered into and
continue to be held for the entity's own use.
One of the ways a contract will be considered
to be settled net in cash is where the entity
has a past practice of taking delivery of the
commodity and selling it within a short
period after delivery for the purpose of
generating profit from short-term fluctuations
in price or dealer's margin. The own use
exemption does not apply to these contracts.
Consequently entities that are dealing or
trading in commodities will normally have to
account for their purchase and sale contracts
Entity Z buys and sells nonferrous metals,
such as copper and aluminium, to generate a
dealing profit. Z sells the metals within a short
period after delivery in the same condition
that they were purchased from Z's suppliers.
Z provides no services related to the metals to
Entity Z's commodity sales and purchase
contracts are considered to be net cash
settled and will be accounted for as derivative
10. Service contracts:
recognition of costs
Revenue and costs that relate to the same
transaction or event are normally recognized
together. For some service contracts
the timing of incurring costs may vary
considerably from the timing of recognizing
revenues. Costs should only be deferred
however when they qualify for recognition as
Entity C provides environmental project
development and advisory services to
customers to assist them in reducing their
carbon emissions. Each service contract
normally lasts for five years. The amount
of consideration is based on the annual
emissions allowances obtained by the
customer during the contract period. Revenue
is recognized when the emissions allowances
are certified each year. C incurs significant
non-recurring set-up costs, including staff
costs, professional fees and travel expenses
in the first year of the contract. There are few
such costs in later years.
The one-off set-up costs will be expensed
as incurred, as they do not meet the definition
of inventory, property, plant and equipment
or intangible assets. Spreading these costs
over the contract period would not be
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